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Business Succession: Meticulous Planning Is A Must

Most business owners spend a great deal of time building a business and very little time thinking about an exit strategy. Day-to-day necessities and the adrenaline of driving business growth make this completely understandable, but also problematic for owners who want to pass along the fruits of their work so that their business will continue to flourish.

Meticulous planning is needed to ensure a smooth, seamless transition, and because of the complexity of a business transfer, a seasoned financial professional that understands multiple disciplines -- finance, tax law, estate planning, and more -- needs to be a strategic advisor right from the start.


A business succession plan is essential

Business owners understand that leaving anything to chance can undermine all the hard work and planning that supported the growth of their business. An oversight can immediately impact revenue growth, or derail long-term growth plans. So too, with passing a business along to the next owner. Failure to have a business plan in place or a poorly executed exit strategy can have a potentially calamitous impact on the value of the business, causing a fire sale. As importantly, it can hurt a spouse or children who need the sale proceeds, create discord with business partners, create unnecessary uncertainty for employees, and hurt vendors and the community in which the business is established. These potential outcomes make a well-conceived strategy essential.


Four key elements of a successful plan

A successful business transition plan reflects four necessary planning elements:

  • Identifying the next generation of owners

  • Establishing and maintaining a talented, committed management team

  • Undertaking a regular valuation exercise

  • Creating a comprehensive estate plan

Each of the steps impacts the others, so they should be viewed as part of a holistic succession planning approach.

Identifying the next generation of owners retention

Before a business owner can act, there needs to be a clear vision of what the business will look like going forward and who will steer the enterprise toward that goal. Is a family member deserving and capable enough to take the helm, or would the business prosper more if an outside buyer is identified and recruited? The answer is critical because it establishes the trajectory of business succession planning. How a business owner prepares for the sale of a business depends on the desired future owners. The realities and challenges for each can be quite different.


Keeping a business in the family can provide continuity and pride for a business owner. It can also raise complex issues: fair treatment needs to be ensured for those family members who don’t assume ownership. If the children remain with the business, but are not cut out to run it, there needs to be family communication backed by contracts to establish guidelines that permit existing management the freedom to run it without the possibility of an heir deciding at some point that he wants to run it.


An employee stock option plan or other employee group sale can be a challenge because a business owner may want to receive a sales price that isn’t sustainable. Additionally, a small business loan to finance the transaction is not always easy to obtain unless there is a bigger buyer group that has sufficient cash to buy out the business owner down the line. But whatever the challenges, selling to a committed, knowledgeable, and motivated group of employees can benefit the business, its workers, and the community in which the business is based.

Sale to a third party

A sale to a competitor, partner, or financial entity (such as private equity firm) can be both appealing and lucrative. The current treatment of capital gains is making this an opportune time to consider M&A or private equity transactions. Finding the right partner may be about more than money; it may include desires for the continuity of values and personnel who contributed to the growth of the business.


Establish and maintain a talented, committed management team

Regardless of whether the new owners are family members in a closely held business or an outside purchaser, a strong management team is imperative. The reason to keep a strong bench in place has a slightly different focus for these two types of purchasers.

For the business that will stay closely held, you want seasoned management to guide an owner’s children as they get their footing. So, if an owner is going to sell to his daughter, he will want someone who can both do their job very well and also be a mentor and help her grow into a leader. Similarly, if employees assume ownership of the business, they will need guidance from a seasoned management team. Employees may understand and excel at components of the business operations but not have the broader managerial expertise to successfully run the company.

For the outside purchaser who doesn’t understand the day-to-day operations of the company, the knowledge and continuity of current management is important to success. Having an able, dedicated management team in place is one of the factors that will be used to value the business. Knowing that the management team will stay after the purchase is equally important when valuing a business.

Business valuation

Business valuation should not be arbitrary and should not be delayed until the time of sale. A classic example of this occurred when a business owner and his partner estimated their business’s value at $1 million and failed to revisit it over time. When the partner chose to sell his interest, the value had grown to over $10 million. For the remaining partner, being able to purchase the exiting partner’s half interest for $500,000 presented quite a bargain.

There are two valuation approaches that can be employed:

Establish a formula

A business owner may decide upon a certain multiple of revenue to create a dynamic valuation metric. Industry trade associations may be a source of information in making that determination. This option can work well if the proper funding for the purchase is in place.

Annual or periodic reviews

The business’s value can be regularly reviewed, preferably on an annual basis. The potential problem for this option is that business owners will be so focused on the business that it won’t get done. It’s critical to make this review a required part of the firm’s operating plan.

Estate planning

Estate planning that maximizes growth and minimizes taxes should be top of mind for business owners. They need to think about the tax-effectiveness of steps they may have taken in the past, and to understand how their asset fits into their ultimate tax obligation. For example, it’s possible to overlook how the value of an illiquid asset, such as a $100 million hotel, can impact a future estate tax liability.

Surprisingly, some wealthy business owners may not think of themselves as wealthy. This may be particularly true if they have been so laser-focused on building their business that they haven’t paid attention to their wealth status. If, as a result, no estate planning occurs, the wealth passed on to the next generation can be severely diminished.

Life insurance can be an elegant solution to reducing this liability. Whatever the solution, it needs to be part of a conversation that is different from a dialogue focused solely on liquidity.


When should business succession planning start?

In a perfect world, business owners should be thinking about getting out the day they get in. Unfortunately, many business owners don’t start thinking about an exit strategy until they want to get out. Or worse still, when they need to get out. If you’re thinking about an exit strategy when you need to get out, you’re at a serious disadvantage.

At a minimum, a business owner should start planning for an exit three to five years before the planned sale date. The discussion about business succession can be viewed as part of a strategic advisor’s risk review.


Tools for a holistic solution

Once a business owner understands the need for a transition plan, a holistic approach that integrates executive retention, succession funding, and estate planning tools is essential. Executive benefits help ensure that an experienced management team remains in place and continues to drive revenue. Life insurance is a flexible tool that enables the new owners to pay the exiting owner, and creates the cash needed to fund the ultimate estate tax obligation the owner(s) and their family will face.

Executive Benefits

A strong executive benefits program is a persuasive retention tool. Deferred compensation plans, Section 162 bonus plans, split-dollar life insurance policies, and disability insurance all provide incentives for key executives to stay with the firm after the founder has left. These benefits take on added importance if the exiting owner will not be available after their exit, whether by choice or by circumstance.

Life Insurance

Life insurance is a highly flexible solution that can be used in a myriad of ways ranging from funding the purchase of a business, to helping an exiting owner fund retirement, pay estate taxes, provide a death benefit for an owner’s family or fund a charitable donation upon death. As a business owner ages, the uses for life insurance can evolve. Additionally, unless a business owner is an ultra high net worth individual, and doesn’t need to be concerned about liquidity, life insurance can be the ultimate liquidity tool.

Permanent vs. Term Insurance

The most important consideration when purchasing life insurance is to have a death benefit in place—whether it be permanent or term life insurance. While the cost of term insurance is lower, it’s important to understand that it is a temporary solution.

Permanent insurance offers the flexibility that allows a business owner to meet changing needs as they age. So, for instance, the cash value can be used for retirement. Or if there is an income tax liability, as is often the case for real estate developers who take depreciation which is later recaptured, it can be used to cover that obligation. And, the death benefit is available to cover estate taxes no matter when death occurs.

Case in point

Three partners owned a successful farm, and the business had a life insurance policy to support their business needs. When one partner opted for retirement, the cash value within their life insurance policy covered the exiting partner’s down payment. They then started to make annual cash payments. When there were two years left on the payments, the exiting owner asked that ownership of the life insurance policy be transferred to him in lieu of cash. The owner had a meaningful benefit that he could leave to his children or grandchildren.


Take the next step now . . .

Business owners spend a tremendous amount of time building a business and, because of their passion, may not imagine themselves ever not running it. But that day will come, and after years of hard work and risk taking, they need to take steps to ensure that their brainchild continues to flourish and that they have sufficient funds for retirement, charitable giving, and estate planning needs. To ensure their legacy endures, they need to:

  • Start planning now, not later.

  • Determine who the next owner should be.

  • Build a strong management team and incentivize it with a compelling benefits program.

  • Build an ongoing valuation program with an eye to the long-term.

  • Incorporate estate planning into the process as early as possible.

And most importantly, because of the complexities of succession planning and the need to be conversant in multiple disciplines including finance, law, and insurance, work with seasoned professionals. TRC Financial can work with you and your advisors to provide the clarity and solutions needed to ensure your legacy lives on.


This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. To determine what is appropriate for you, please contact us to discuss. Information obtained from third-party sources are believed to be reliable but are not guaranteed.

The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that neither M Financial Group or TRC Financial are engaged in rendering tax, legal, or actuarial services. If tax, legal, or actuarial advice is required, you should consult your accountant, attorney, or actuary. TRC Financial should not replace those advisors

All examples are hypothetical and for illustrative purposes only and may not reflect the typical clients experience; they are not intended to represent or guarantee that anyone will achieve the same or similar results.

An insurance policy’s financial guarantees are subject to the claims-paying ability of the issuing insurance company.

Cash value accumulation is determined by the policy contract, is not always guaranteed, and is subject to withdrawals. Cash values and death benefits may vary based on the policy you purchased. Please consult your full policy illustration at the time of purchase.

Loans and partial withdrawals will decrease the death benefit and cash value and may be subject to policy limitations and income tax.

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